MT217 Unit 10 Capital Budgeting Report Example

Fails the Payback Rule, Adds $124,000 in Value: A Unit 10 Capital Budgeting Report on Hotel Rooftop Solar

[Student Name]

Purdue University Global

MT217: Finance

Unit 10 Capital Budgeting Report

[Instructor Name]

[Date]

The hotel, the project and every figure are composite and illustrative; bracketed figures stand where vendor quotes and utility bills would supply the numbers; the sources cited are real.

Recommendation

The hotel should install the rooftop solar and battery system. Although it takes about 5.6 years to repay its cost, longer than the owner's five-year rule, it is worth about [$124,200] more than it costs at the hotel's 8.5 percent cost of capital, yields about 12.7 percent a year on the money and returns about [$1.20] in present value for every dollar invested. The payback rule should be treated as a check on risk, not as the deciding test.

The Project

The Larkin Hotel is a composite 140-room full-service hotel near a convention center in Sacramento, with a restaurant, a pool and meeting space. Its electricity bill runs about [$310,000] a year, highest in summer afternoons when air conditioning and peak utility rates coincide. A solar installer has proposed a system of panels on the hotel's flat roof and over part of its parking lot, with battery storage to cover the late afternoon peak.

The installed cost is [$610,000], after the federal tax credit available to the project and before any utility rebates, which are not assumed. The panels carry a 25-year performance warranty, the inverters about 12 years and the batteries about 10.

Cash Flows

The project's benefit is the electricity the hotel no longer buys, net of maintenance and after tax. The installer's production estimate, applied to the hotel's actual rate schedule, gives after-tax savings of [$96,000] in year one. Savings rise as utility rates increase and as the hotel shifts more of its peak use onto the batteries: [$102,000] in year two, [$107,000] in year three, [$112,000] in year four, [$117,000] in year five, [$119,000] in year six, then [$120,000], [$121,000], [$122,000] and [$123,000] in years seven through ten. The ten years total [$1,139,000].

The analysis stops at ten years, the battery warranty, even though the panels should keep producing well beyond it. That makes the results conservative. Panel output also declines slowly with age, about half a percent a year under the warranty terms, and the savings figures already reflect that decline; the rising savings come from rate increases outpacing it.

Payback

Cumulative savings reach [$534,000] after five years, [$76,000] short of the cost. Year six brings [$119,000], so the remaining amount is recovered about 0.64 of the way through that year, for a payback period of about 5.64 years. By the owner's rule, which requires payback within five years, the project fails.

Payback is easy to understand and shows how long the hotel's money is at risk. In the Graham and Harvey (2001) survey of finance chiefs, a majority reported using payback at least some of the time, especially in smaller firms, alongside net present value. But payback ignores everything after the cutoff and counts the year-five savings at full face value, as though they arrived the day the panels went up.

Net Present Value and Profitability Index

Discounting each year's savings at 8.5 percent gives a present value of about [$734,200]. After the [$610,000] installed cost, about [$124,200] of value remains. Each invested dollar brings back roughly 1.20 dollars in today's money, the project's profitability index.

What it means: at the hotel's cost of capital, the project creates about [$124,200] of value for the owners, and that figure counts only ten years of a system expected to run for twenty-five. Brigham and Houston (2019) describe net present value as the most direct measure of how much a project adds to a firm's value, because it accounts for the timing and risk of every cash flow.

Internal Rate of Return and Discounted Payback

The Larkin's solar savings break even, in present value terms, at a discount rate of about 12.7 percent, which is the project's internal rate of return and sits more than four points over the hotel's hurdle. The discounted payback period, counting savings in present value, is about 7.8 years, still well inside the panels' warranty.

The project fails a five-year rule and still pays for itself, in today's dollars, with more than two years of warranty to spare on the batteries.

Sensitivity

Three tests show how much the conclusion depends on the estimates. If savings came in 15 percent below the installer's forecast every year, net present value would fall to about [$14,000], still positive. At a 10.5 percent hurdle instead of 8.5, net present value would be about [$60,300]. If installation ran 10 percent over budget, at [$671,000], net present value would be about [$63,200]. The project remains worthwhile in each case, though the savings shortfall comes closest to erasing its value, which is why the installer's production estimate should be checked against the hotel's own meter data in the first year.

Why the Payback Rule Misleads Here

The owner's five-year rule was written to protect a seasonal business from tying up cash in projects that might not pay back before conditions change. It works well for short-lived equipment like kitchen fixtures. For a long-lived asset with a 25-year warranty, it rejects a project that adds value. Ross et al. (2022) note that payback is biased against long-term projects, and this is a clear example.

There is also a timing argument the owner may find persuasive. The hotel's largest bills fall in July and August, when convention business and air conditioning peak together, and the battery is sized to cover exactly those afternoons. The project reduces the hotel's exposure to its most volatile cost, which is a kind of risk protection the payback rule does not measure.

A reasonable compromise is to keep the payback rule as a screen for short-lived investments and to judge long-lived ones by net present value, with payback reported alongside as a measure of how long the money is exposed.

Risks and Next Steps

Three risks deserve attention. Utility rate structures can change, reducing the value of avoided peak use. The batteries will need replacing around year ten, a cost not included because it falls at the end of the analysis. And roof work may require repairs the installer has not yet priced. Before signing, the hotel should obtain the roof assessment, confirm the tax credit amount with its accountant and ask the installer for a production guarantee. If those three items come back as expected, the project should go ahead before next summer's peak season.

References

Brigham, E. F., & Houston, J. F. (2019). Fundamentals of financial management (15th ed.). Cengage.

Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2-3), 187-243. https://doi.org/10.1016/S0304-405X(01)00044-7

Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2022). Fundamentals of corporate finance (13th ed.). McGraw-Hill.